Fed Not as Hawkish as Expected

Good day… I want to start off today’s Pfennig by apologizing for those of you who were waiting to receive their Pfennig yesterday. I sent it off at the normal time, but we had some problems with the program that sends it out, so it was delayed in getting delivered. You can always view the current Pfennig at our website where we post it first thing in the morning. That website also has archived versions of past Pfennigs for your reading pleasure! They tell me the problem has been fixed, so you should get this Pfennig right on time.

The dollar drifted higher throughout most of the day yesterday as the markets prepared for the FOMC rate announcement. The sentiment driving the dollar higher was that the Fed would sound much more hawkish in order to keep an overall consensus among the FOMC members. Dollar bulls were expecting a signal from Bernanke that an increase in interest rates would be just around the corner. These higher interest rate expectations encouraged traders to take the dollar index back up to just under 74, a level we haven’t seen in almost two months.

But Federal Reserve policy makers didn’t deliver, and composed a fairly neutral statement to deliver to the markets (just as we had expected). The central bank, which left its benchmark rate at 2%, said that “downside risks to growth remain”, dropping a reference in June’s statement to “diminished” dangers. The Fed also said that price increases are of “significant concern.” The statement indicates that the Fed realizes that they will be forced to leave interest rates at the current level until next year. The sluggish U.S. economy has taken away their best weapon against inflation, so they will just have to sit back and hope the credit crisis ends and inflation begins to ease.

Just after the announcement, the dollar got sold off (as I would expect) but then regained its strength and finished the day with the dollar index closing in on 74 again. Overnight markets moved the dollar lower again, but Europe ran it back up. With all of the negative data here in the United States, and an FOMC that has been neutered by a slowing economy, the dollar strength really has me perplexed. From the cheap seats, it sure looks like intervention in Europe. Why else would the dollar continue to gain strength? Lower oil prices certainly have helped propel the dollar, but oil has actually moved up about $1 in early European trading while the dollar continues to rally.

Yes, I know the Eurozone has been posting some pretty poor numbers. Just this morning Germany reported that factory orders in the second quarter dropped for a seventh straight month in June. Manufacturing has slowed in Germany and Europe, as a stronger euro (EUR) has weighed on demand for exports. The continued slowdown in German industrial production increases the likelihood that the Eurozone is slipping into a recession.

But the ECB has never wavered from their mandate for price stability. This dogged fight against inflation will help maintain the long-term value of the euro. This latest dollar rally just doesn’t make sense when you look at the overall global economic picture. Yes, growth in the Eurozone is slowing, and Germany may be slipping awfully close to a recession, but the United States IS in a recession! And while the impotent FOMC sits back and ‘hopes’ that inflation will abate, the ECB has had the courage to continue its fight against inflation.

The past month has been hard on holders of foreign currencies, but investors have to look past this dollar correction. Only three major currencies have outperformed the euro since the beginning of 2008: the Brazilian real (BRL), Mexican peso (MXN), and Swiss franc (CHF). In the long run, I have to believe the inflation fighting of a strong ECB will help to maintain the euro’s value versus the U.S. dollar.

So today the markets’ focus will shift to the upcoming BOE and ECB interest rate meetings. ECB President Jean-Claude Trichet is expected to keep interest rates unchanged, but may signal that higher interest rates will be needed to combat inflation. Trichet will hold a press conference after the ECB announces its decision tomorrow, at 1:45 PM in Frankfurt. The currency markets will be listening to his every word, trying to uncover any indications of a change in his hawkish stance against inflation. Until then, the dollar will likely remain in a fairly narrow trading band versus the euro.

The Bank of England is also expected to keep rates unchanged, but the pound (GBP) will likely continue to come under pressure as many feel the BOE has been ineffective in its policy decisions. U.K. consumer confidence fell the most in at least four years, as England deals with a housing market slump that rivals our own. The markets have lost confidence in the Bank of England’s ability to deal with the current economic situation, and the pound continues to fall because of it.

A drop in commodity prices, along with the slowdown in the United States has caused the Canadian dollar (CAD) to lose value. The loonie is down over 4% versus the U.S. dollar this year after soaring 17% in 2007. The drop in oil prices and shrinking exports to the U.S. is to blame. While Canada has forged closer trading ties to China, a majority of exports still flow south into the ailing economy of the United States. With demand here expected to slow even more, the Canadian dollar has sold off. With an abundance of commodity riches, the Canadian dollar should be somewhat protected against further losses.

The fall in commodity prices, along with increased speculation of a rate cut has caused a continued fall in the Australian dollar (AUD). The Aussie dollar traded near the lowest in four months as both oil and gold declined. Commodity exports contribute 17% to the nation’s $1 trillion economy. And interest rate speculation has provided the second blow in a one-two knockout combination for the Australian dollar. Traders are betting that the RBA will lower its benchmark rate by 0.87 percentage points in the next 12 months according to an index that tracks interest rate swaps trading. Australian home loan approvals fell to a four-year low in June, the statistics bureau said today, adding to signs the economy is cooling. Unfortunately, the Aussie dollar looks like it will remain in a downward trend for the short term, but just like the Canadian dollar, I would expect their commodity riches to keep a floor under the currency. Long-term currency investors should look at this recent sell off as a buying opportunity instead of a crying opportunity.

I am going to cut it off short today and head right for the currency round up as it is getting late.

Currencies today 8/6/08… A$ .9148, kiwi .7229, C$.9494, euro 1.5470, sterling 1.9535, Swiss .9495, ISK 78.90, rand 7.4385, krone 5.1915, SEK 6.1027, forint 152.80, zloty 2.0977, koruna 15.51, yen 108.60, baht 33.60, sing 1.3783, HKD 7.8051, INR 42.09, China 6.8484, pesos 9.9069, BRL 1.5746, dollar index 73.92, Oil $119.41, Silver $16.69, and Gold… $885.95

That’s it for today… Sorry for the shortened Pfennig today, but it was a pretty late night last night as I went out to the Cards game with a few of the guys on the desk. It was a great game, as we got to see Manny Ramirez and Joe Torre of the Los Angeles Dodgers. Our ace, Chris Carpenter, who just recently returned, started for the Cardinals and held the Dodgers scoreless through five, but after an extended rain delay LaRussa pulled him and gave the game to our suspect bullpen who lost a 4 run lead in the 9th inning. Luckily our newest all star, Ryan Ludwick smacked a two run homer in the 11th to secure a victory. With two rain delays and extra innings, I didn’t get to bed until much later than I’m used to. Thanks to John Ryan of our Jacksonville office for some great tickets!! I hope everyone has a Wonderful Wednesday!

Chris Gaffney
August 6, 2008